Frequently Asked Questions (FAQs) on the
White Paper on enhancing the Single Market framework for investment funds

Why not also seize the opportunity to tackle fundamental issues regarding
the scope and the approach of the UCITS Directive?

The Commission is aware that some parts of the industry have doubts regarding
the capacity of the UCITS Directive to respond to continuous evolution in fund
management techniques. There are also concerns that some retail funds are denied
the benefits of a single market passport. The Commission is giving consideration
to those concerns. However, many of the issues regarding the scope and design of
the Directive have not yet crystallised sufficiently to allow a considered
assessment of the associated benefits, costs or options. A first analysis
carried out by Commission services reveals insufficient grounds to undertake a
fundamental revision of the Directive at this stage.

Therefore, in line with the better regulation principle, the Commission
favours a progressive approach. In a first instance, the objective will be to
modernise and complement the Directive in a number of specific and targeted
areas. Then, on the basis of a structured review of the need for changes to the
scope and regulatory approach of the Directive, further more far-reaching
measures could be envisaged. This review will be launched early 2007. It will
culminate in a report on this issue to the Council and the European Parliament
in 2008.

The Commission does not believe that product regulation and UCITS legislation
in particular have passed their sell-by dates. Financial innovation poses big
challenges for prescriptive rules on investment fund portfolios. Going forward,
regulation may need to concentrate less on the way that fund portfolios are
constructed and more on the way that they are managed, marketed and sold.
However, rules to ensure the sound structuring, governance and management of
funds will remain a staple of our regulatory system. This will particularly be
the case for products destined for fast-track access to the retail market. That
is why we must persevere in our efforts to modernise the UCITS Directive. The
changes that we are proposing in the White Paper are an important step towards
simplifying the regulatory overheads for UCITS investment funds and to ensuring
the continued relevance of the UCITS 'model' in today's fast-changing
market.

Does the Commission still believe that there is no need for EU action on
hedge funds?

Firstly, it is a myth that European hedge funds are not regulated. In the
European Union, hedge fund managers, administrators and products are subject to
wide-ranging national regulatory requirements. There are also regulatory
mechanisms in place at EU level (e.g. capital supervision) and ongoing
monitoring by banking supervisors to limit bank exposure to hedge funds. There
are enhanced market disciplines enforced by hedge fund counterparties such as
prime brokers which are EU regulated banks. European rules on market abuse and
insider trading apply fully to hedge fund managers intervening on a European
financial market. In this respect, the situation is very different from the US
where there has been limited regulatory action on hedge funds to date. Our
analysis suggests that there are currently no regulatory gaps which call for
EU-level intervention to regulate hedge funds above and beyond those measures
that are already in place at national and European level. Before taking any
action in this area, there would also need to be confidence that any such
intervention would actually achieve some useful outcomes. There is a particular
danger that hedge fund regulation could stifle the further development of a
sector that has thrived on flexibility and a capacity to innovate.

However, we are not turning a blind eye to this asset class. The Commission
and other EU and national authorities are carefully monitoring the ways in which
growth of the hedge fund industry can impact the EU financial system. The
Commission is paying particular attention to the extent to which hedge
fund-based investing is being made available to the mass market –
including through shares in listed hedge funds and funds of hedge funds.

How does the White Paper relate to the expert group report on hedge fund
support services?

The expert group on hedge funds have put forward four recommendations
regarding hedge fund support services: appointment of a custodian on a
pan-European basis, custodian liability regime, re-hypothecation limits and net
asset value (NAV) calculation. These technical recommendations refer to support
services for hedge funds which are marketed only to investors capable of
self-directed investment decisions. The report analyses the current situation
where there is no single market mechanism or framework for hedge funds as well
as for the choice of hedge fund service providers. The recommendations are
mainly addressed to Member State authorities who are urged to take a flexible
and convergent approach with respect to the providers of hedge fund
administration services and custody functions.

The Commission welcomes the report's contribution to this debate. The
Commission is also of the view that there are currently no clear grounds for
action at EU level to create a framework for hedge fund support services. We
note that the hedge fund expert group clearly stated that none of its
recommendations would warrant legislative action at EU level. Existing
competitive forces should prove sufficient to encourage those Member States that
want to develop a hedge fund market to tackle, amongst other aspects, the
regulatory barriers hindering the provision of strong operational and finance
services to their hedge fund industry on a cross-border basis. However, the
White Paper does put forward that the Commission will further study the question
of non-harmonised funds. In this context, we will also carefully assess
regulatory barriers and inefficiencies in support services.

It might be, for instance, appropriate to explore in the context of our
reflections on a "private placement" whether hedge fund products proposed only
to "eligible" investors could benefit from pan-European operational support and
finance services that are subject to specific/lighter regulatory requirements
which reflect the sophisticated nature of the investor base.

Is specific action required at EU level in response to the growth and
impact of hedge funds and private equity firms?

The Commission recognises that hedge funds, private equity funds and other
"activist" investors are increasingly challenging and influencing incumbent
management's decision-making and the strategic direction within the portfolio
companies in which they invest. Some argue that this investment may occur at the
expense of the interests of longer-term shareholders and employees. However, it
should be recalled that these investors are doing no more than exercising the
rights that they have earned by taking a stake in publicly listed company.
Regulatory safeguards exist at European level to ensure that all investors
– including hedge funds and private equity firms – publicly disclose
their acquisitions and refrain from any abusive behaviour or insider trading.

Should hedge funds be subject to tougher transparency
requirements?

The Commission has looked at hedge funds and other institutional investors
should be subject to greater transparency of shareholdings or be obliged to
disclose their voting policies. These questions were extensively debated during
the Commission consultation on its Action Plan on Company Law and Corporate
Governance. The Commission's view is that effective initiatives have been
undertaken at international level (eg the International Corporate Governance
Network), and that such mechanisms not only function satisfactorily but also
cater for the flexibility that market participants need.

The Commission sees even less rationale for curtailing the ability of these
categories of investor to exercise the voting powers that they acquired in
publicly quoted companies. Such restrictions would be a departure from the
principle of 'one share, one vote', and would undermine the healthy disciplines
that open markets for corporate ownership are starting to impose on European
boardrooms. However, the Commission considers that confidence in open markets
for corporate ownership requires the respect of good corporate governance by all
investors. These requirements extend equally to hedge funds and private equity
funds. We look to the industry and its trade associations to contribute to a
climate of confidence in respect of their activities.

Which aspects of the White Paper will benefit investors as they come to
terms with a more complex range of funds?

Cost savings and new market openings for the industry should translate into
tangible improvements for the end investor in the form of lower charges or
higher returns, but also in terms of access to continued enhancements in product
performance. To achieve this purpose, investors will need improved,
understandable and reliable disclosure allowing them to select competitive
products offering the most attractive risk-return combinations. They also need
to be able to count on the quality and objectivity of the services provided by
financial advisors or intermediaries who sell investment funds to them.

The White Paper foresees action on two levels to ensure that market dynamics
work to the advantage of the end investor:

Firstly, the White Paper commits the Commission to implement regulatory
principles to ensure that fund distributors put the interests of the end
investor first when recommending or selling investment funds. Fund selection
should not be influenced by the level of commissions paid by fund managers to
distributors. The Markets in Financial Instruments Directive (MiFID) provides
the necessary framework to manage and disclose conflicts of interest and
inducements. The White Paper foresees that the Commission will ensure that these
rules are implemented consistently and effectively in ways that ensure that
investors can rely on distributors to direct them towards the top-performing and
most competitive funds in the market.

Secondly, the White Paper foresees a programme of legislative and
non-legislative action to correct the failings of the simplified prospectus: the
simplified prospectus was intended to provide the average retail investor with
basic information about the product so as to enable him/her to make an informed
investment choice. However, extensive consultation with industry, consumers and
regulators showed that it is not meeting these objectives. The Commission will
therefore undertake radical surgery on the simplified prospectus so that it
provides risk, cost and performance disclosures in ways that are intelligible
and useful for the end investor. This will be done in close association with
national authorities and other stakeholders and will include extensive consumer
testing. The result will hopefully be a standardised disclosure document that
helps the investor to understand the key features of the proposed fund
investment, and to select the fund investment that best corresponds to his/her
expectations.

Will the proposed legislative adjustments deliver significant increases in
the efficiency of the European investment fund industry?

The adjustments will benefit the industry both directly and indirectly:

Direct effects will result, for example, from the envisaged changes to the
notification procedure and the simplified prospectus. Furthermore, the changes
regarding mergers, pooling and an effective management company passport will
open up opportunities for the industry to reap economies of both scale and
specialisation.

Indirect effects are no less important. They should come about primarily
through an increase in competition: a simplified prospectus that provides the
relevant information in a clear way that is easy to understand for retail
investors will increase transparency in the distribution part of the value
chain. With investors able to easily assess the costs and investment policies
(i.e. success) of poorly performing funds, expensive funds will be put under
pressure to improve their operational efficiency and/or investment strategies.
In addition, cross-border market integration – brought about through a
more efficient notification procedure, amongst other things – will also
force fund companies to improve their performance in order to be able to compete
with top-class competitors.

How will the Commission ensure that the new provisions for fund managers
will not increase cost and complexity and undermine effective
supervision?

Effective supervision is one of the conditions for high levels of investor
protection, which has been a crucial ingredient in the success of UCITS concept.
The strengthening of passporting arrangements and new single market freedoms
will entail a reallocation of supervisory responsibilities and more complex
cross-border fund structures.

However, these do not have to come at the expense of less effective
supervision. An integral part of the White Paper covers new provisions to
strengthen supervisory cooperation and establish mechanisms to detect and stamp
out instances of cross-border abuse. Similarly, solutions to concerns about
effective supervision have be found in other sensitive fields of securities and
banking law (such as MiFID, the Prospectus Directive, banking supervision and
market abuse).

Will regulated investment funds be undermined by competition from less
regulated substitute products?

The Commission is certainly aware of these concerns. We will monitor the
developments in this area attentively and assess if there is a need for action
at EU level.

Is there is a case for the creation of a single market passport for real
estate funds?

The responses to the Green Paper and to the Expert Group report on
Alternative Investments have stressed that the Commission should consider
whether measures for creating a single market passport for retail-oriented real
estate funds should be taken in the coming years. Funds investing in property
cannot be authorised as UCITS. However, over the past decade real estate funds
have become an important asset class in many Member States, for institutional as
well as for retail investors. Open-ended real estate funds in particular are
already used widely by retail investors as a product for long-term savings and
retirement provisioning.

Due to different regulatory approaches at national level and due to the lack
of an EU passport, the European real estate investment market is fragmented and
cross-border distribution of real estate funds is marginal. The Commission has
therefore decided to set up an Expert Group on retail-oriented real estate funds
with the mandate to examine whether real estate funds are suitable for sale to
retail investors, and if so, what are the barriers to a single market and how
they could be most appropriately overcome, taking into account the costs and
risks of EU-level intervention. The Expert Group will present a report to the
Commission in 2007, on which stakeholders will be able to comment.